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  • pg 1
									How to Overcome
‘Korea Discount’?
          May 13th 2004

   by Chairman Chul-kyu Kang
of the Korea Fair Trade Commission

I would like to extend my deepest appreciation to members of the Asia
Society for their excellent efforts to promote mutual understanding and
cooperation between Asia and the United States. Moreover, I am very
delighted to be here as a keynote speaker at the 14th Asia Corporate
Conference under the theme of “Envisioning the World‟s Next Great
Market: Korea and the Economic Future of Northeast Asia”.

In particular, I would like to address the issue of measures to overcome the
“Korea Discount” covered during this forum, which is very significant and
directly related to the future advancement and growth of the Korean

These days, “Improvement of corporate management” has emerged as a
major issue both at home and abroad. The OECD‟s pursuit of setting up
“Principles of Corporate Governance” to protect investors‟ rights can be
seen as part of such efforts. Under these circumstances, it is very timely
and meaningful to cover this important topic.

<Korean companies’ PER, much lower than overseas competitors>

I feel very sorry about “Korea Discount”, which means devaluation of
corporate value of companies by foreign investors and underestimate of
real value in share prices. In terms of price earnings ratio or PER, Korean
companies are relatively underestimated compared with those in other
developed countries as well as emerging countries. To help your
understanding, I would like to take an example. Samsung Electronics
boasts strong business performance in par with that of IBM and Intel while
its share value is lower than its overseas competitors.

As of 2003, the PER of Samsung Electronics was about 9.2 while that of
Nokia was 14.9, IBM, 18.6, and Intel, 22.1. Furthermore, the figure is less
than that of Taiwan Semiconductor Manufacturing Company or TSMC (17.5),
the leading Taiwanese semiconductor manufacturer, which has one- sixth of

the turnover and one-third of net profits compared to Samsung Electronics.

According to the data, released by UBS Warburg in 2004, average PER of
companies in Asian emerging markets is 13.6 and that of Chinese
companies is 14.3 while the PER of Korean companies marks 9.1.

This „Korea Discount‟ triggers a number of problems, such as an increase
in capital costs for domestic companies and an underestimated brand value.
All in all, it will have harmful effects on growth potential of the Korean
economy, by reducing efficiency in resource allocation in the overall
economy. I believe, when „Korea Discount‟ is addressed, not only foreign
investment will be boosted but also corporate value will increase, thereby
nurturing growth potential.

<Reason: Lack of Transparency in Business Management>

Korea Discount resulted from a combination of various economic and non-
economic factors in Korea, such as lack of flexibility in the labor market, a
weak financial system and national security issues including the nuclear
problem in North Korea.

The main reason for such underestimated value, identified by both
domestic and foreign experts is the lack of transparency in business
management. Less respect to minority shareholders, insufficient
information disclosure, illegitimate internal trading and excessive control
by controlling shareholders can be seen as examples for non-transparency.

Such undue practices are mainly attributed to distorted corporate ownership
and governance structure. In particular, in case of business conglomerates,
using circular shareholdings between affiliates triggers the excessive gap
between cashflow rights and voting rights, leading to negative effects on
corporate value and lower confidence at home and abroad. Not only that,
but this huge gap makes it possible for controlling shareholders to easily
monopolize the decision making process, violating the minority
shareholder‟s rights. In addition, it also hampers the effective functioning
of internal and external control system.

Recognizing the severity of this problem, the Korean government has made
a lot of efforts to improve corporate governance since the 1997-98 financial
crisis. As a result, substantial progress has been achieved, such as improved
financial structure and more respect to shareholders.

However, as we have noticed after the SK scandal, nontransparent business
practices still remain. Furthermore, controlling families maintain or even
expand their control through complicated multi-level shareholdings
between affiliates with a small amount of share ownership. In other words,
progress and changes so far have fallen short of our expectations.

A recent evaluation on transparency and fairness in internal and external
control system of listed companies carried out by KDI also supports this
view. Regarding internal control systems, our average of listed companies
is 38 (the best company in Korea rates 76), which is much lower than that
of our benchmark, Pfizer (97). Such disappointing figure stems from low
independence of outside directors, insufficient monitoring by board of
directors, and lack of diversity in the way of exercising voting rights by

In the case of external control system, the level of introduction scores 80,
which is near to our benchmark, the United States (89). However, the rating
for real functioning is 45, which clearly requires a lot of efforts for
improvement. This is mainly because of insufficient information disclosure
and low independence of external auditing. In addition, there are not
enough mechanisms for investors and consumers to hold business
executives accountable for any of their mismanagement.

According to the results of a survey on a large number of domestic and
foreign investors, they expressed their intention to put 24~34% of premium
to shares of Korean companies, if these companies have an improved
corporate governance. This clearly shows that the main reason for the
„Korea Discount‟ lies in the underdeveloped corporate ownership and
governance structure.

<The 3-year Market Reform Roadmap>

The most effective way to address Korea Discount is to steadily pursue
market reform to establish transparent and fair economic system. When
transparent and fair market environment is set, competition in each field
can be promoted, thereby enhancing market confidence and gradually
solving the problems of Korea Discount.

To this end, the government made and announced “the 3-year Market
Reform Roadmap” last year, suggesting a blueprint of reform policies
regarding companies, business conglomerates and market.

In particular, endeavors are made to improve market regulation mechanism
on corporate sector. For enhanced transparency in accounting and decision-
making process, the checks and balances system among controlling
shareholders, minority shareholders, board of directors and other
stakeholders in companies and business conglomerates is to be established.

In order to prevent side effects arising from dominance of industrial capital
on financial capital, monitoring over financial soundness will be
strengthened and the scope of exercising voting rights over the shares of
other affiliates held by financial affiliates will be reduced. In the securities
sector, class action lawsuit has been already introduced, taking into effect
in 2005. In addition, electronic voting system in the shareholder meeting
can be partly an answer to an environment where external control and
monitoring functions over business activities done by management
executives and controlling shareholders are effectively carried out.

For enhanced corporate ownership and governance structure of business
conglomerates, the current regulation of setting the ceiling on total amount
of shareholding of other domestic companies is to be improved. To this end,
first of all, the KFTC strives to encourage companies to expand
information disclosure on corporate ownership and governance structure,
and to exempt the business groups with low gap between voting rights and
cash flow rights from the regulation.

In other words, gap between cash flow rights and voting rights should be
reduced while the organizations under the corporate law, such as board of
directors and shareholder meetings, should take their place as effective and
well-functioning decision-making bodies.

If the ownership and corporate governance structure of large business
conglomerates is improved and a market monitoring mechanism works
effectively within three years, the direct regulations such as the ceiling on
total amount of shareholding of other companies imposed by the
government will be completely reviewed.

<Future of Business Conglomerates>

The ways of changing the corporate ownership and governance structure of
business conglomerates can vary, depending on the situation of each group.

However, the following methods can be considered as examples:

   - Transform the ownership structure to a simple and transparent
     holding company structure.
   - Maintain the loose relationship under which the affiliated businesses
     share the same brand name with more independence.
   - Divide the business conglomerates into smaller business groups, or
     separate into independent businesses in some cases.

The KFTC thinks that the holding company system can be an alternative to
advanced corporate governance in terms of transparency, planning to make
compensation measures to facilitate the holding company.

However, transformation to a holding company cannot address all the
distorted problems of corporate governance nor all business conglomerates
cannot be transformed to holding companies either. Nonetheless, our
expected effects include simple and transparent vertical relationship of
shareholdings, improved independent management of affiliates under a
holding company, easy entry and exit of market and less risk of chain-
reaction bankruptcies.

Undoubtedly, the best clear answer to advanced corporate governance lies
in enhanced transparency and formation of „Checks & Balances System‟.
Depending on their situation, they should explore the most appropriate
corporate governance for themselves.

<Closing: Strengthened market competition to promote growth>

In the global competition era, the substantial part of business
competitiveness stems from confidence and trust. It is no doubt that
corporate value heightens when confidence increases.

Such confidence can be gained from transparency in business management
and effective decision-making process. Such environment is possible when
there is a well-functioning internal and external control system. In other
words, confidence can be expected when there is sound corporate

Thanks to the success of industrialization focusing on business
conglomerates since the development-oriented era, Korea is now at the
threshold of becoming advanced economy. Even though a lot of progress
has been made in corporate governance, there still remains a long way to
go. Existence of „Korea Discount‟ can be seen as such evidence.

In order to improve the situation, the Korean government made and
announced „the 3-year Market Reform Roadmap‟ last year to enhance
transparency and fairness, preparing for its legislation this year. If it is
pursued as scheduled along with effective functioning of internal and
external control system, business transparency and confidence in Korean
companies and conglomerates can be surely improved. Not only that, but
this will result in addressing the problems of „Korea Discount‟.

Thank you for listening.


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